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Monday, August 3, 2009

Investing is Like Surgery?

Happy Civic Holiday! This isn’t the most festive holiday, but it beats working. This is a holiday version on the regular Sunday feature looking back at selected articles from the early days of this blog before readership had ramped up. Enjoy.

One of the choices investors have to make is whether to handle their investments themselves or work with (and pay) a financial advisor. People have a lot to say on both sides of this issue, but I’ve heard one clever argument several times now. It goes something like this:

“You wouldn’t do your own surgery, right? So, why would you try to handle your own investments? Leave this stuff to the experts.”

On the surface, this reasoning seems compelling. The image of some guy trying to operate on his own belly is pretty amusing. Anyone who comes up with a catchy line that makes people laugh must be right.

But, this analogy breaks down very fast. Exactly who is the brilliant surgeon in the financial world? The financial planning industry would say that the average investor is not as smart as a surgeon, and I agree. Maybe professional money managers who run mutual funds are the surgeons. But these professionals as a whole don’t do any better than the stock market averages. When we take into account the fees charged to investors, index funds outperform actively-managed mutual funds over the long run.

So, professional money managers aren’t the surgeons in the analogy. This leaves financial advisors. Fee-only financial advisors might fit here. They are usually smart people who are paid for their time to give unbiased advice rather than being paid by mutual fund companies to sell their funds. I wouldn’t exactly call fee-only financial advisors surgeons, but the analogy is close.

What about the typical financial advisor who is paid commissions out of the fees that mutual funds charge to investors? Could these people be the surgeons? I could make a joke here, but let’s just say no they aren’t. These financial advisors are more like salespeople. Just like other types of salespeople, there are good ones and bad ones. But they all have to eat, and they feel the constant pressure to sell financial products that earn them commissions.

There is a lot of money at stake, and the financial industry is willing to spend heavily on marketing. It is important to understand the basics of investing even if you choose to use a financial advisor. You need to know enough to tell whether you are getting good advice or are being taken for an expensive ride.